Using a Tax Free Savings Account (TFSA) in Retirement

The Tax Free Savings Account is still a relatively new way to save in Canada. It was introduced by the Conservatives in 2009 as tax-advantaged account unique from the RRSP.

Modeled after the Roth IRA in the U.S.A. and the (much better) ISA in the U.K., a TFSA allows you to contribute after-tax money to an account up to a specified annual limit that increases every few years with inflation. Unused room is carried forward indefinitely.

Once the money is in a TFSA account, you can invest in anything from stocks and ETFs to GICs. Or you can open a simple bank savings account in a TFSA format that earns pitiful interest.

Although the name can be confusing, the TFSA is a flexible account structure, not just a place to park your money at the bank for 0.6% interest. To invest in ETFs and stocks, you should open a self-directed TFSA with a brokerage like Questrade.

All of the investment returns earned within the account are completely exempt from all Canadian taxes, including standard income tax and investment taxes such as dividend taxes and capital gains taxes. Wisely invested, a TFSA should grow into a million dollar account over a lifetime.

As long as you are careful not to double contribute, money can be withdrawn from your TFSA account at any time without penalty. This makes the TFSA an ultimate investment account in terms of flexibility!

Withdrawals from a TFSA are not even reported on your tax return. It is as if you earned nothing at all! The benefits of this should not be understated.

TFSA Statistics

Right now the vast majority of Canadians are wasting the value of this awesome tax advantaged account.

To explain, here are some statistics on TFSAs straight from the CRA.

Canadians with TFSA Accounts:  12,731,020 (about one-half of adult Canadians)
Canadians who Maximized their TFSA:  1,249,900
Average Unused TFSA Room:  $24,191.99
Average Account Value per Holder:  $15,205.96

Even the wealthiest Canadians, those individuals earning over $250,000 per year, are ignoring the power of TFSAs. Of these wealthy Canadians who even bothered to open a TFSA, the average account value lingers around $30,560.

If you were over the age of 18 in 2009 when TFSAs were introduced, there is no reason why you shouldn't have $60,000 or more in your TFSA right now. That is $5,000 contributed every year returning 6% per year. (We have been in a bull market after all...)

Best Use for TFSAs

The TFSA should be used for one thing, and one thing only. Retirement savings! But as I will clarify later, a specific kind of retirement savings.

Any suggestion that TFSAs can be used to save for a new car, buy a house, buy new furniture or a new TV, vacations, or anything else should be dutifully ignored and even scorned.

Anyone who depletes a TFSA while they are young to buy something is a complete idiot! And count me in that category since I did exactly that with my ~$20,000 TFSA in 2011 when I bought a house.

Thanks to aggressive saving after realizing my idiocy and good investment returns, my TFSA and my wife's TFSA are both back in the $70,000 range.

The problem with making early withdrawals from your TFSA is that you lose the investment returns on the withdrawn money.

Plus, if you let the contribution room get away from you, it can become nearly impossible to catch up on your contributions.

If you take just $15,000 out of your TFSA to buy a house when you are 25, you will be $155,000 poorer at 65 years old. That's a wasted potential tax-free investment gain of $140,000.

A TFSA for Retirement

The TFSA account should be used in conjunction with an RRSP (or pension) to save for retirement. When carefully done, you can achieve amazing wealth with extremely low tax liabilities in retirement.

$1,000,000

Source: PortfolioVisualizer.com

If you would have saved just $5,500 a year ($458 per month) for the past 30 years, you would have seen your account grow to $1,000,000.

Returns since 1987 were good, but there's absolutely no reason to believe this won't happen again over the next 30 years. Your TFSA can be worth some real serious money if you invest assertively.

If you get past the constant drama of the naysayers, there is truly no better time financially to be a young saver in Canada! Ignore the mourning of those disappearing crappy workplace pension plans, the TFSA in your own hands is a much better tool.

A TFSA offers fantastic flexibility, affluence, and freedom from taxes. Three things a workplace pension cannot give you.

Effective Use of a TFSA in Retirement

In your retirement savings strategy, your TFSA will form just one component of your total retirement income.

First, there will be the fully taxable income which you cannot control to any significant degree. This includes things like government benefits and workplace pensions.

You may be surprised that this annual income is likely to be $15,000 per person, or more. If you have a larger RRSP or a workplace pension, it can be significantly higher.

By their design, the minimum seniors income after all government benefits is likely to cover the basic costs of living if you have a paid-off residence. A combined annual income of $30,000 should pay for things like utilities, food, a vehicle, and basic entertainment.

Also, after seniors tax deductions, an income of $15,000 per person will be completely tax-free in nearly every province. It may actually qualify you for additional benefits in some provinces.

A TFSA can be perfectly paired on top of this foundation of basic income to keep you completely tax-free in retirement and fully eligible for every government benefit that is accessible to you.

TFSAs should be used as a highly tax efficient way to pay for the extras, especially lump sum expenditures, without jeopardizing your benefits.

TFSAs are a very tax efficient way to pay for things like home renovations, large vacations, new vehicles, or other high cost items.

If you have a larger TFSA, one worth approximately $1,000,000, you can live a truly luxurious tax-free retirement. We know that an account this size can afford annual withdrawals of $40,000 to $50,000 a year.

If both partners in a relationship have large TFSAs, a tax-free investment income of $80,000 to $100,000 a year plus government benefits of $30,000 is a very real and foreseeable scenario for high saving Canadians.

One issue is there already have been discussions about using TFSA values when determining qualification for low income benefits.

It is all but certain sometime in the next decade or two, as TFSA values expand, TFSAs will be considered when applying for benefits. There is a reason why the CRA is tracking this stuff.

Although total net worth and lifetime tax-adjusted net worth may not necessarily be the highest when using a TFSA compared to a RRSP, the TFSA forms a very important part of your retirement savings options.

The flexibility and ease of use of TFSA's are unmatched!

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